Alistair Darling: Banks too important to break up

It's just over two years since RBS, then one of the world's biggest banks, came within hours of collapse. And this was just weeks after HBOS faced meltdown because of bad lending decisions.

Two of Scotland's biggest banks were in ruins. The immediate consequences were very bad, but could have been even worse. Had we not acted, bank doors would have closed. The cash machines would have stopped working. Other banks would have been in trouble within hours, and hundreds of thousands of jobs in the banking industry would have gone.

The Labour government moved quickly to stabilise Britain's banking system. Provided the new government handles the transfer back into the private sector properly, taxpayers will get every single penny back - and more.

However, challenges remain, both here and abroad. This was always a global financial crisis. As we see in Ireland, the world is not out of the woods yet. Ireland, a small country, is faced with standing behind all three of its big banks, and those same banks are dependent on funding from the European Central Bank. Understandably, as it has said, action has got to be taken now to draw a line under this crisis.

Here in the UK, quite rightly, questions are being asked about how we can make our banking system safer. Banking can never be risk free, but we need to make it safer.

We must also recognise the reliance of today's economies on an efficient financial sector. Business, and families, need credit. And of course the financial services industry employs more than a million people. Edinburgh would have been devastated if RBS and HBOS had been left to their fate.

The new government has set up a banking commission to advise it and it is due to visit Edinburgh today. I believe it can come up with constructive proposals, but I hope it will reject the simplistic calls to break up Britain's banks.

The advocates of that course argue that if banks had stuck to the simple business of taking in money from savers, and lending it out again, then they wouldn't have failed. Their role model is the type of bank that would have been run by Captain Mainwaring in days gone by.

However, this argument falls flat on its face when we look at what has happened over the last three years. Northern Rock was a pretty simple bank. It provided savings accounts, it offered mortgages, but it was dependent on raising money in America. When that dried up the bank collapsed.

Bradford and Bingley and the Dunfermline Building Society were also pretty straightforward operations, but they overreached themselves and fell.The second argument was that while governments might have to step in and look after banks that took in savings, they can leave the big investment banks to go to the wall. This is nonsense. The Americans tried exactly this with Lehmans. They allowed one of Wall Street's biggest investment banks to founder, and within a couple of weeks the rest of the world's banking system was on the edge of collapse.

The truth is, in times of crisis, letting any bank collapse is a massive risk - one you cannot afford to take.

But there is another point missed by those looking to break up the banks. Do that and two things will happen. The biggest global banks will simply pack up and go. We may not like that, but it's a fact of life. For others, such as RBS or Lloyds, if they are broken up it will be foreign banks that will strip them of the assets that they want and leave the rest to us.

That would be a huge blow to Edinburgh. Sadly, jobs have gone, but to lose the headquarters of big banks like RBS would be disastrous, not just for the city and for Scotland.

The City of London matters to the whole of the UK. We should think long and hard about giving a significant part of it away. No other country would join in, and many would be happy to pick up whatever they could.

We do need to make changes. Banks need to hold more capital. Regulation needs to be tougher - and crucially more effective - not just here but in every part of the world. This crisis has shown just how interconnected the banking system is.

Boardrooms, which were responsible for many of the biggest failures, need to be overhauled. Non-executives are there to ask tough questions, not just to collect their fees.

The commission should also look at a number of other proposals. Banks must be required to have "living wills", contingency plans agreed with the regulators, so if they get into difficulties they can be wound down or transferred to other banks very quickly and in a way that doesn't leave the taxpayer footing the bill.

We started work on this, but the effort must be stepped up.

Secondly, we need to deal with the problems that arise from having an overseas bank with substantial branches in this country. That was the problem we faced with the Icelandic banks - they operated in the UK but were regulated elsewhere. In some cases, the London branch was bigger than their operations in Iceland.

Thirdly, trading in derivative products should be done through transparent exchanges where people can see what's going on far more clearly.

It was obvious during the crisis that far too many bank boards had no idea just how much risk they had taken on trading in products they simply didn't understand.

Finally, there is the big question of competition in the banking system. There isn't enough of it. We need one or two new major players if we are to get more lending at competitive prices.

To me this is one of the most important points.The high street doesn't have enough banks. Without getting this right we risk hamstringing the recovery just as it gets going.

It's very easy to trash this financial sector. Understandably people, including many bank employees, are angry, having paid a price through no fault of their own.

The truth is we need the industry as a source of lending, for services like pensions, and as an employer. And remember, a lot of the financial services industry - the insurance industry for example - didn't get into trouble and is very important to us, including in Edinburgh.

We need to get this right. Reform is essential, but having spent billions of pounds on stabilising the banking system it would be ironic if we ended up giving it all away as a result of simplistic, populist calls. This industry is too important to this country, in every sense.

• The Rt Hon Alistair Darling is Labour MP for Edinburgh South-west and was Chancellor of the Exchequer from June 2007 to May 2010.